Warren Buffett's wager on U.S. housing market pays off for Berkshire Hathaway

Berkshire’s Class A shares rose this week to the highest in 16 months. The Omaha, Nebraska-based company, which is expected to report second-quarter earnings tomorrow, is about 3% away from the top closing price since 2008.

I don’t know if he’s lucky, smart or patriotic, but it’s worked out for him

Buffett added to holdings of Wells Fargo & Co., the largest U.S. home lender, bought real-estate brokers and bid on mortgage assets of bankrupt Residential Capital LLC as he bets on a rebound in housing in the world’s largest economy. Rather than spend his company’s cash pile on European companies after a 2008 trip to the region, he made his largest acquisitions in the U.S., including Fort Worth, Texas-based railroad Burlington Northern Santa Fe.

“I don’t know if he’s lucky, smart or patriotic, but it’s worked out for him,” Cliff Gallant, an analyst at KBW Inc., said in a phone interview. He estimates that Berkshire will post an operating profit of US$1,750 a share for the second quarter, a 6.7% increase from a year earlier.

The economy in the 17-nation euro area may contract this year as governments institute austerity measures to lower borrowing costs, according to the median estimate of 35 analysts surveyed by Bloomberg. Buffett said last month that Europe’s monetary union may fracture if its leaders can’t rewrite their rules, while U.S. housing was beginning to show signs of a rebound after the worst crash in seven decades.
Housing Improves

“For the last two years, I’ve seen everything except housing moving forward in the economy,” Buffett, 81, told Betty Liu in a July 13 interview on Bloomberg Television. “In the last few months, the rest of the economy actually has flattened out. Housing is picking up.”

The number of available U.S. homes has been declining, a trend Buffett has said was inevitable as new households form. Properties for sale fell to 2.39 million in June from an average supply of 2.93 million in 2011 and 3.22 million in 2010, data from the National Association of Realtors show.

A turn in the housing market will benefit Berkshire’s businesses tied to home building and repair, said Josh Brown, who helps oversee US$350-million at Fusion Analytics Investment Partners LLC in New York, including Berkshire shares.

“Buffett has spent the past decade amassing a portfolio of companies that are involved with home remodeling,” he said in a phone interview. “It’s got the right drivers if this housing trend continues.”

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Berkshire Businesses

Berkshire’s subsidiaries include Acme Brick Co., paint maker Benjamin Moore & Co., builder Clayton Homes and carpet manufacturer Shaw Industries. The firm has stakes in some of the country’s largest mortgage lenders, including U.S. Bancorp and Bank of America Corp. The Wells Fargo stake was valued at more than US$13-billion at the end of March, making it the second- biggest holding in the company’s stock portfolio.

“When we compare Berkshire to the macro economy, there’s more exposure to housing,” Meyer Shields, an analyst at Stifel Nicolaus & Co., said in a phone interview. “That should mitigate some of the other disappointing areas of the economy.”

Gross domestic product, the value of all goods and services produced, slowed to a 1.5% annual rate in the second quarter from 2% in the first three months of the year as limited job growth prompted Americans to curb spending, U.S. Commerce Department data released July 27 showed. Federal Reserve policy makers said yesterday that “economic activity decelerated somewhat over the first half of this year.”

Buffett’s Deals

Buffett struck a deal last August to buy preferred stock and warrants for US$5-billion in Bank of America, the second- largest U.S. lender, after its shares plunged amid costs tied to soured mortgages. A month later, the billionaire said he wouldn’t come to the aid of European lenders in need of capital.

Berkshire offered to buy ResCap for US$1 before it entered bankruptcy protection in May. Buffett’s firm is set to be the lead bidder for the company’s loan portfolio in a court- supervised auction this year. Nationstar Mortgage Holdings Inc., backed by Fortress Investment Group LLC, will be the first bidder for ResCap’s mortgage servicing and underwriting business, which Berkshire had also sought.

Buffett has favored the U.S. for larger acquisitions. He hasn’t announced any deals valued at more than US$1-billion for European companies after visiting Germany, Switzerland, Spain and Italy in 2008 to scout potential targets.

U.S. Acquisitions

Berkshire’s 2010 buyout of Burlington Northern for US$26.5-billion was an “all-in wager” on the U.S. economy, Buffett has said. The firm spent about US$9-billion last year for Wickliffe, Ohio-based Lubrizol Corp.

A recession in Europe could still hurt Berkshire because it has subsidiaries that operate there as well as bullish derivative bets on equity indexes in the region, said Shields. Lubrizol has struck deals to buy at least two companies in Spain since being acquired by Berkshire in September.

European leaders are deepening their ties in response to the sovereign debt crisis by collaborating on bailouts and insisting on budget-deficit curbs. Buffett said last month that the number of nations involved has made action more difficult.

“The system that they put in place had a fundamental fatal flaw” of a common currency without a common fiscal policy, Buffett said on Bloomberg Television in July. “It can’t survive with the present rules. That’s what they’re learning. The question is: Can 17 countries get together in a way to essentially redo something?”

Still, Buffett’s company may be benefitting from a “flight to quality” as Europe’s troubles worsen, Shields said. Berkshire had a US$37.8-billion cash hoard at the end of March.

Investors may be speculating that Buffett will be able to cut deals amid market dislocations that boost shareholder returns, said Shields. Berkshire took stakes in Goldman Sachs Group Inc., General Electric Co. and Swiss Re Ltd. during the 2008 financial crisis. The securities were redeemed last year for more than US$12-billion.

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